The next oil shock?

VIA the BigGav – Oil is “the lifeblood of modern civilisation”. This paper provides an overview of the global oil market. In particular, it examines the outlook for oil supply and demand over the next five years, and the economic consequences.

• Low-cost reserves of oil are being rapidly exhausted, forcing oil companies to turn to more expensive sources of oil. This replacement of low-cost sources of oil with higher-costs sources is driving the price of oil higher. 
• While the world will not run out of oil reserves for decades to come, it cannot indefinitely continue to produce oil at an increasing rate from the remaining reserves. Forecasts indicate that world oil production capacity will not grow or fall in the next five years while demand will continue to rise.
• If oil production capacity does not rise as fast as demand, the buffer of spare production capacity disappears. In such a ‘supply crunch’ the price of oil ‘spikes’ to high levels. High oil prices can induce global recessions.
• Organisations including the International Energy Agency and the US military have warned that another supply crunch is likely to occur soon after 2012 due to rising demand and insufficient production capacity
• There is a risk that the world economy may be at the start of a cycle of supply crunches leading to price spikes and recessions, followed by recoveries leading to supply crunches

Oil market basics

Not all oil is the same. The source and the quality vary. The graph below shows approximate oil reserves divided by type of reserve and production cost.

Estimates of the total amount of oil are hotly debated. The typical estimate is that there were originally between two and three and a half trillion recoverable barrels of conventional oil. [6]  

So far, about 1.3 trillion barrels of oil – mostly the cheapest, most easily accessible, highest quality oil – have been produced, leaving about 1.7 trillion more barrels of conventional oil in the ground. It is estimated that a further six trillion barrels of non-conventional oil could be produced from sources such as tar sands, bitumen, and gas or coal-to-liquids. [7]  

Not all the oil that is thought to be in the ground has been found. The key measure of discovered oil is “proven reserves” (also called “proved reserves”), which is the amount of oil in a given field that the owner is 90 percent confident is present and can be extracted with existing technology. [8]   As of 2009, the official total of proven reserves worldwide, including non-conventional reserves, stood at 1.25 trillion barrels of conventional oil and 150 billion barrels of Canadian oil sands. [9]   At the rate of production forecast by the United States Energy Information Agency, [10]   proven reserves would be sufficient to meet world demand for another 25-32 years, providing that oil production capacity can continue to expand.

Few big oil reserves have been found in recent decades. Oil companies must drill more wells in increasingly difficult and expensive locations to find the remaining undiscovered reserves. Oil discovered per new well is declining. In 17 years between 1963 and 1980, 15,000 wells found nearly 1.5 trillion barrels of oil. In 22 years between 1980 and 2002, 60,000 more wells found half as much new oil. It now takes approximately 10 wildcat wells on average to discover the same quantity of reserves as a single wildcat well would discover 50 years ago. [11]  

The diagram below illustrates the world’s oil reserves, along with the average daily additions to and the consumption of those reserves.

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